Madoff Justice

Longtime readers know my belief that our society is over-regulated and under-punished. Convicted swindler, Bernie Madoff, got off easy at 150 years. Assuming this 71-year-old man actually lives another 150 years, it means he will have to spend only a few seconds in jail for each dollar stolen and only 40 days for each victim swindled. He has lived 70 years in extremely fine style, funded by his victims. Now, he will live out his remaining years with no worries about food, clothing, housing, and even have better medical care than many Americans, all funded by the taxpayers. At some point, a person indeed becomes “above the law”.

Financial journals are now discussing the “lost generation” of investors, people so traumatized by Madoff that they have become paralyzed with fear and confusion. That would be the greatest damage that Madoff has accomplished. The $65 billion that may have already been lost by his victims is nothing compared to the profits that this “lost generation” will miss.

By the way, kudos to Sen. Jim Webb, who is crusading for a new perspective on our prisons. With 5% of the world’s population, we have 25% of the world’s prisoners. And, at what cost? How many hospitals could we build with the money we spend feeding, clothing, housing and caring for prisoners? Or, how many more aircraft carriers could we afford? Now, we must pay for a pampered swindler!

Change is coming.......

It was obvious last September when the markets crashed, following the Lehman failure. It became certain last December with the arrest of Madoff. There will be a re-regulation of the securities markets, which is desperately needed. Of course, “the devil is always in the details”!

Last week, the Obama Administration introduced their plan for re-regulation. It is large, complex, and far-reaching but certainly unlikely to be implemented as presented. The most interesting part to me is whether financial advisors should be held to a suitability standard or to a fiduciary standard. It is an important difference and could re-shape the industry. A stockbroker is currently held to a suitability standard, which only requires the advisor to present investment choices that are “suitable” for the client. On the other hand, financial advisors who are Registered Investment Advisors are required to act in the client’s best interest, not the advisor’s best interest, nor the firm’s best interest. Currently, neither the stockbroker nor the firm must act in the client’s best interest. The new chairman of the SEC recently advocated that all advisors be held to a fiduciary standard, which means every stockbroker of every firm will be incurring fiduciary liability for the firm. That is an enormous unseen and unknowable contingent liability to every firm. They may well sell pieces of their retail business to brokers and spin them off into separate legal entities.

Regardless, I don’t plan to own any shares in brokerage firms until this is made more clear. It is a BIG change!

The Wisdom of Crowds?

All year, I’ve been advising clients that the economy would “bottom-out” in the fourth quarter. Last week, the latest survey of the National Association of Business Economics (NABE) showed that 90% of economists believe the bottom will be late this year. (As a member, I naturally participated in that survey.) Maybe, I should feel comforted that so many economists agree with me, but there is an old joke among economists that the purpose of forecasters is to make astrologists look respectable.

At this point, my forecast for the U.S. economy remains the same, but something very different is happening to the financial markets. While there has never been a sharp V-shaped recovery from a credit-driven recession, this appears to be happening in the market now, and the only explanation I can believe is that the reversal is coming from the emerging markets, which are not as dependent on credit or capital. Stay tuned . . . we certainly do live in interesting times!

The Problem with Averages

I was reading a marketing piece from one of the mass market financial advisors. His argument was that since the average recession since the Great Depression has been 21 months and since the stock market has been up an average of 45% twelve months later and since this recession is now officially 19 months old, then it must be time to get fully invested in stocks. Averages can be so misleading!

Over the same period, recessions have ranged from 3 months (twice) to 62 months. Credit-driven recessions, like this one, tend to be longer than inventory-driven or trauma-driven recessions. Also, the average bounce-back of 45% twelve months later has been declining markedly. The first 3 recessions bounced-back an average of 72% while the last 3 only bounced back 25% on average.

Averages can be so misleading! Like every investor, every recession is unique and should be evaluated individually!

A Sainted Businessman

In the early 1990s, I was appointed by the Governor of Texas to the State Depository Board, where I served with the State Treasurer, State Banking Commissioner, and State Controller. We wrestled with the collapsing Texas Savings & Loan Associations, which had wrecked the Texas economy so badly. I was there when the legendary Bill Seidman arrived with the federal Resolution Trust Corporation. It was like Moses parting the sea. It was an experience I’ll never forget. Bill Seidman was a man I’ll never forget. America has lost one of those great businessmen, who made the life of every American even better, even though they’ll never know.

R.I.P. Bill Seidman

The Un-Stressful Stress Test

After all the stressful suspense, the "Stress Test" results were released last Thursday, and it wasn't as bad as I feared. Still, there are two lingering issues. First, the assumptions were 10.3% unemployment, GDP dropping 3.3% in 2009 and rising 0.5% next year, and home prices falling another 27%. I'll be surprised if unemployment doesn't exceed 10.3% by the first quarter of next year. I suspect GDP growth will not be as good this year nor as bad next year. And, with record low home mortgage rates, it is hard to forecast another 27% drop in home prices. Overall, the government did a good job.

The second lingering issue is that the Stress Test only looked at nineteen banks, but what about the thousands of other banks, many of which are heavily exposed to local commercial real estate loans? Many analysts believe that is the next big shoe to fall.

As always, the things we know that we don't know worry us the most!

Maybe Bernanke Is Right?

Today, I watched a speech by Ben Bernanke discussing the cause of the current Great Recession. For several years, he has been warning about the “savings glut”, i.e., those nations like China who run huge cash surpluses and lend the cash back to the consuming nations, effectively pushing up debt levels in our national economy. I’ve always felt like that was blaming somebody else for the mess we created. Bernanke gently hammered that point again today, and I’m starting to believe him. Regardless, it is one more reason we should become an exporting-oriented economy, which benefits from a weaker dollar.

Back To The Future

Yesterday we learned the U.S. trade deficit decreased unexpectedly. The surprise was not that imports fell for the seventh consecutive month, but that exports actually rose for the first time in six months, despite the strong dollar. Our trade deficit in 2006 was $681 billion compared with an estimate of only $373 billion this year. Nice trendline, indeed!

Early stage economies tend to grow by being export oriented. Mature economies tend to grow by being consumption oriented. The rest of the world has long envied our consumption based economy, which consumed their products. They were only too happy to continue lending us money to buy their goods. But, the world has changed . . .

To change our consumption orientation and again become an export economy, we need a cheaper dollar, which is the inevitable result of inflation. In other words, maybe we actually need inflation!

A Greater Wrong

While I am as disgusted as all those pontificating politicians about the AIG bonus issue, there is a greater issue than this additional instance of unfairness, and that is the sanctity of contracts.

While contracts can be set aside for a few narrow reasons, this is not one of them. Even worse, over-turning these contracts will have a very chilling effect on dealing with the many other financial problems we face, because the private sector won’t trust the contracts they negotiate.

The TALF plan is dependent upon contracts with funds to clean up the toxic assets. Would you want to do business with the Federal government, to help clean it up, when you don’t know if the contract will be honored or not?

Revenge may be sweet, but it has a bitter aftertaste!

Our future leaders are impressive

Last week, I spoke before 750 people for Virginia Beach’s annual “State of the City” address. It was a piece of cake!

I also spoke before the 24 brightest high school seniors in Virginia Beach, who are competing for a large scholarship. That was intimidating! These kids are so bright. They asked questions about the difference between Keynesian economics and Austrian economics. They asked how to protect themselves from people like Bernie Maddoff. Amazingly, they seemed resigned, but not angry, about inheriting all the debt we are piling on them. They were a much tougher audience.

Sometimes, it is nice to be reminded that our country’s future is in good hands, indeed!

Jobs Report reflects long year ahead

A year ago, I predicted unemployment would reach nine percent. On Friday morning, the Labor Department released the monthly “Jobs Report,” showing unemployment had already reached 8.1 percent, the worst in 26 years.

If you add in the under-employed, those people who are forced to work part-time or who have given up, 14.8 percent of the workforce is struggling. As if that wasn’t bad enough, don’t forget that unemployment is a “lagging indicator,” which means it will not improve until after the economy improves, which is not expected before the fourth quarter of this year.

That means unemployment is likely to rise all year, making a 10 percent level of unemployment almost a certainty. The rate of under-employment could even approach an unthinkable 20 percent. It will be a very long year indeed for millions of people.

Economics is not a religion

Sitting at a traffic light yesterday, listening to Rush Limbaugh’s speech to the Conservative Political Action Committee, I saw pick-up trucks go by, helpful for small cargoes. I saw 18-wheelers go by, helpful for large cargoes. I saw cement trucks, refrigerated trucks, and even a fire engine -- all helpful tools for specialized missions.

Some people, especially politicians, see economics as a religion, rather than a tool box. If you are trying to get the economy out of a deep ditch, Keynesian economics has a proven track record. If you are trying to stimulate a sluggish, under-performing economy, supply-side economics has a proven track record. If you are dealing with a specialized mission, such as inflation/deflation, monetarism has a proven track record.

There is a difference between a flathead screwdriver and a Phillips screwdriver, and each tool accomplishes a specific mission.

Stock market actions should be observed with steady hand

Yesterday, we learned that the fourth quarter was worse than we thought. In fact, it was the worst in 26 years. We thought our economy shrank 3.8% but learned it actually shrank 6.2%. Not too surprisingly, the stock market was disheartened and lost even more wealth.

The perspective of time is everything. When we were originally told last month that the economy shrank 3.8%, we were expecting to be told 5.5%. The stock market liked that and created wealth that day.

The stock market can be expected to over-react, which emphasizes the importance of not obsessing about any one report or any one day’s performance. If you have a real life outside your portfolio, this is a particularly good time to enjoy it!

Job loss mounts worldwide

The Jobs Report this morning showed another 598,000 Americans lost their jobs, the most in 35 years. The unemployment rate jumped from 7.2% to 7.6%. Totally heart-breaking! Don’t look for foreclosures to slow down . . .

So far in this recession, 3.5 million of us have lost our jobs. But, that pales in comparison to China, where some reports indicate 26 million workers have lost their jobs. The possibility of social unrest there should not be minimized. As they are our second most important trading partner, we need them to stay healthy enough to buy our goods, as well as to keep buying our Treasury debt.

Will the 'January Effect' ring true

Uh, oh . . . one of the oldest Wall Street adages is the “January Effect,” which states that … so goes January, so goes the year. The bad news is that the Dow lost 8.4% this month, the worst January in history, indicating a terrible 2009. A little piece of good news is that the “January Effect” is not ALWAYS correct.

More bad news was Friday’s report that the GDP decreased 3.8% in the fourth quarter, the worst since 1982. More good news is that we were expecting a decrease of 5.5%.

Oh, yeah . . . then there is Warren Buffett’s ageless and priceless advice to … be fearful when others are greedy and be greedy when others are fearful.

Nothing chills a market like uncertainty

I’ve seen this show before. The best thing about seeing it the first time was that it did eventually end!

There is now much discussion about a “good bank/bad bank” approach to solving the credit crisis. The problem is that banks cannot be sure how much capital they have to lend, because it's impossible to know the value of some of their assets right now. For example, banks don't know the value of their mortgage-backed securities because everybody is afraid to either buy or sell them. Nothing chills a market like uncertainty! The market is frozen.

I was in Texas during the 1988 - 1992 “Savings & Loan Debacle” when the Federal government created the Resolution Trust Corporation to buy the assets from the troubled S&Ls, replacing uncertainty with certainty, while wiping out the shareholders of the S&L. It worked! Credit flowed. The recovery of Texas began.

Doing this on a much grander scale will be much more difficult, but it must be done. Uncertainty must be replaced with certainty, before our national recovery can begin. Everybody will be relieved when this show is over, and we can write/read the “credits.”

Investors duped by Madoff broke basic investing rule

The media is full of stories about Bernard Madoff, who allegedly lost somewhere between $17-50 BILLION by cheating his investors with a “Ponzi Scheme.” It is a story so similar to the WexTrust issue locally.

While I feel sorry for the individual investors, some of whom were destroyed, they did forget the most basic rule of investing, i.e., ALWAYS have an independent, third party custodian of the client’s assets, who will send statements directly to the investors.

If my mother asked me to manage her money, my first question to her would be “Who is the custodian?”

Supporting auto industry now saves wealth

Yesterday, the highly-regarded economist of Economy.com, Mark Zandi, testified before the Senate Banking Committee that a bankruptcy of the Big Three car makers would be a catastrophe for the wider economy, as well as the stock market. Upon questioning, he thought the $34 billion in loans being requested would be insufficient in the long run, and that they would return in another year or so for more funding. The senator referred to this as “kicking the can down the road.”

Zandi is right! It would be a catastrophe. However, that doesn’t mean we shouldn’t let the car makers take bankruptcy later. So far, economists have estimated $12 trillion of wealth has been destroyed. Is it worth $34 billion now to prevent more trillions of wealth destruction? Absolutely!! There is a time to euthanize the car makers, but it is not now. In a year, our economy will have a much better chance of weathering their bankruptcies.

Geithner announcement a ray of sunshine

In the past two weeks, the Bush Administration announced it would not seek the second $350 billion of the $700 billion “bailout” package approved by Congress. Also, Treasury Secretary Hank Paulson said there would be no new initiatives to deal with the credit crisis. So much for that promise to do “whatever necessary” to stem the crisis.

Sensing increased uncertainty amid this lack of leadership, the stock markets began falling further, setting new lows. Simply, there was no good news to give hope.

Suddenly on Friday, it was announced that Tim Geithner would be the new Treasury Secretary and the market responded with a nearly 500 jump in the Dow. As head of the New York Fed, he is intimately familiar with the ways of Wall Street, and as the former Under Secretary of Treasury for International Affairs, he understands the globalized nature of this recession. It was an excellent choice! It was also a little ray of sunshine that the markets desperately need.

G-20 meeting filled with intrigue

If the journey of a thousand miles begins with a single step, this weekend was probably a good first one. Albeit reluctantly, the U.S. convened a special meeting of the 20 most economically important nations in D.C. this weekend, which was described as the “Platitude Summit.” The nine-page closing press release contained a pledge of closer cooperation, to meet again, and . . . “never again.” However, the important meetings were in the hallways, where creditor nations must have posed interesting hypothetical deals to Obama’s two representatives who are attending. There will be no press release of those discussions, but it is no coincidence that Obama sent a former Secretary of State instead of a former Treasury Secretary. (I hope it was a good omen that he sent both a Republican and a Democrat as his direct representatives, but we’ll see.)

Also, the concept of a “College of Supervisors,” consisting of the G-20 finance ministers, is interesting, but it will need broad investigative powers, if not regulatory powers. The U.S. opposes giving it regulatory power, but Europe is strongly in favor of that. One good thing to come out of this meeting was a real push for uniform accounting standards, which would be a giant step toward transparency.

Was today the bottom?

Long time veterans of Wall Street believe it is not safe to say the bottom has been reached until the market touches closing price on the worst day a second time and bounces back up. Today, the market did that and ended with a huge 552 bull run. Does that mean the bottom is here and that it is finally safe to invest some of our cash . . . or open our 401(k) statements again?

From a technical standpoint, today didn’t exactly meet the test. While the S&P broke through its previous low, the Dow did not. And, the recovery was sloppy, more like a roller coaster than a rocket. Nonetheless, we are certainly closer to the bottom than the top. When the Dow is again 14,000, will it really matter if we bought in at 7,500 or 8,500?

Increase in money supply is terrifying

If you are a supply-side economist, you believe personal behavior and economic performance can be controlled by tax rates. If you are a Keynesian economist, you believe economic performance can be controlled by fiscal policy, i.e., taxes and spending levels. If you are a monetarist, you are terrified by this chart, because an historic, astronomical increase in money supply like this is certain to create terrible inflation.



For the first time, I really hope the monetarists are wrong, but . . .

ISM Report Is Telling

The S&P fell 3.9% last week. One of the primary reasons was the latest ISM Report by the Institute of Supply Management. A score of 50 indicates no growth. A score of 40 indicates a serious recession. This week, it was 38.9, which is the lowest since September 1982. Look at this graph.



The rapid fall is certainly stunning! But, notice the pattern of quick reversals as well. As scary as things are, keep in mind this too will pass! I’ve written that the bottom of the economic cycle could be Q2 of next year but now suspect it will be Q3. We’ve been through this 11 times since World War II. This one is longer and deeper, but we’ll get through this one too!

U.S.'s creditors to be knocking on the door soon

Below the radar, there was a meeting this weekend of 43 European and Asian nations in Beijing to prepare a “comprehensive reform of the international monetary and finance system.” The U.S. was not invited. At the Nov. 15 international financial summit in Washington, D.C., we can expect the rest of the world to present their plan to us. Essentially, our creditors met this weekend, and they will present their “workout plan” to the debtor next month. While it is certainly NOT the end of the world, it is the end of the era when we can dictate to the rest of the world.

The stock markets hate uncertainty. By the end of next month the presidential election will be over and the future shape of the international financial system will begin peeking at us. Besides, November is historically a much better month than either September or October . . . thank goodness!

Russia and China positioning smartly amid crisis

I’ve always been told that “he who has the gold, makes the rules” and hope that is not always true. For decades, the Russians have wanted better refueling operations in the north Atlantic for its Navy. A few weeks ago, Iceland nearly went bankrupt and was very desperate. Immediately, Russia was there with a $3 billion handout. After all, Russia has $556 billion in foreign currency reserves and needs increased presence in the north Atlantic more than it needs the money!

But that pales next to China’s $1,906 billion or $1.9 trillion. They are also the largest holders of U.S. debt. First, our economy over-leveraged or took on too much debt. Now, our government is assuming much of that debt for us. The best way for the U.S. to de-leverage is to do something really, really nice for the Chinese. I can only guess . . .

Working a deal with them quickly would be very good for our markets immediately, but I do worry about the long run. Of course, the famous economist, Lord John Keynes, was fond of pointing out that “in the long run, we’re all dead!”